The Web of Sri Lankan Monetary Policy Unwound

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Here are some thoughts from Dr Indrajit Coomaraswamy, Governor of the Central Bank of Sri Lanka, who was the keynote speaker at the recently concluded Economic Outlook seminar held at the Ceylon Chamber of Commerce.

What happened in 2018?

A look at Sri Lanka’s monetary policy in 2018 remains crucial to understanding the future of monetary policy in the country. April of 2018 denotes a significant point as the Central Bank reduced interest rates by 0.25%, following a period of low inflation and low economic growth. The decrease, according to the Governor of the Central Bank can be interpreted as a formality marking the shift of the CBSL from a stance of strict tightening bias (increasing policy rates) to one of neutral bias regarding monetary policy.

However, the shortage of rupee liquidity in the market led the CBSL to further reduce the Statutory Reserve Ratio applicable on rupee deposits held by commercial banks in November 2018. Thereby, allowing banks to freely increase their lending resulting in a liquidity injection into the market. This injection was in turn balanced off by the CBSL through a rise in policy rates. However, as 2018 drew to a close, it was a year with a highly depreciated rupee and diminishing foreign reserves.

The rupee depreciation and Monetary policy

Though the rupee’s 19% depreciation in 2018 resulted in a significant impact on the cost of living, according to the Governor it was not as acute as in past decades, where majority of the country’s staple diet of rice was imported whereas now, only a minor proportion is imported. The effects on living costs were further dampened by weak commodity growth in the global market.

The Governor further started that in analysing, the effects of cost push inflation as a result of the rupee depreciation, urban areas were seen to be impacted more as rural consumers increased their dependency on home grown agricultural products.

In 2019 all focus is on growth. However, due to the enormous pressure exerted on the exchange rate and foreign reserves, monetary policy remains a limited option in achieving this growth according to the Governor of the Central Bank. Therefore, despite inflation being well within the lower bound of the CBSL’s target range ( 4-6%), a rate reduction may not come anytime soon.